Key questions to consider before pulling the trigger
By Robert J. Pyle, CFP®, CFA
You’ve worked incredibly hard to build your business, medical practice or law practice. But, despite enjoying a robust income and the material trappings of success, many business owners and professional are surprised to learn that their retirement savings are way behind where they need to be if they want to continue living the lifestyle to which they’ve become accustomed.
In response, many self-employed high earners are increasingly turning to Cash Balance Plans (CBPs) in the latter stages of their careers to dramatically supplement their 401(k)s—and their staffs’ 401(k)s as well. Think of a CBP as a supercharged (and tax advantaged) retirement catchup program. For a 55-year-old, the CBP contribution limit is around $265,000, while for a 65-year-old, the CBP limit is $333,000—more than five times the ($62,000) limit they could contribute to a 401(k) this year.
Boomers who are sole proprietors or partners in medical, legal and other professional groups account for much of the growth in CBPs. For many older business owners, the tax advantages that come with plowing six-figure annual contributions into the CBPs far outweigh the costs.
As I wrote in my earlier article: CBPs: Offering a Break to Successful Doctors, Dentists and Small Business Owners, CBPs can offer tremendous benefits for business owners and professionals who own their own practices….especially if they’re in the latter stages of their careers. There are just some important caveats to consider before taking this aggressive retirement catchup plunge.
CBPs benefit your employees as well
Business owners should expect to make profit sharing contributions for rank-and-file employees amounting to roughly 5 percent to 8 percent of pay in a CBP. Compare that to the 3 percent contribution that's typical in a 401(k) plan. Participant accounts also receive an annual "interest credit," which may be a fixed rate, such as 3-5 percent, or a variable rate, such as the 30-year Treasury rate. At retirement, participants can take an annuity based on their account balance. Many plans also offer a lump sum that can be rolled into an IRA or another employer's plan.
Common retirement planning mistakes among successful doctors
Three things are pretty common:
1) They’re not saving enough for retirement.
2) They’re overconfident. Because of their wealth and intellect, doctors get invited to participate in many “special investment opportunities.” They tend to investment in private placements, real estate and other complex, high-risk opportunities without doing their homework.
3) They feel pressure to live the successful doctor’s lifestyle. After years of schooling and residency, they often feel pressure to spend lavishly on high-end cars, homes, private schools, country clubs and vacations to keep up with other doctors. There’s also pressure to keep a spouse happy who has patiently waited and sometimes supported them, for years and years of medical school, residency and further training before the high income years began.
Common retirement planning mistakes among successful dentists
Dentists are similar to doctors when it comes to their money (see above), although dentists tend to be a bit more conservative in their investments. They’re not as likely to invest in private placements and real estate ventures for instance. Like doctors, dentists are often unaware of how nicely CBPs can set them up in their post-practicing years. They’re often not aware that they have retirement savings options beyond their 401(k)…$19,000 ($25,000 if age 50 and over). For instance, many dentists don’t realize that with a CBP they could potentially contribute $200,000 or more. It’s very important for high earning business owners and medical professionals to coordinate with their CPA who really understands how CBPs work and can sign off on them.
Common objections to setting up a CBP
First, the high earning professional or business owner must commit to saving a large chunk of their earnings for three to five years—that means having the discipline not to spend all of their disposable income on other things such as expensive toys, memberships, vacations and other luxuries.
Another barrier they face is a reluctance to switch from the old way of doing things to the new way. Just like many struggle to adapt to a new billing system or new technology for their businesses or practices, the same goes for their retirement savings. Because they’re essentially playing retirement catchup, they’re committing to stashing away a significant portion of their salary for their golden years. It can “pinch” a little at first. By contrast, a 401(k) or Simple IRA contribution is a paycheck “deduction” that they barely notice.
A CBP certainly has huge benefits, but it requires a different mindset about savings and it requires more administration and discipline, etc. However, if you have a good, trustworthy office administrator or if you have a 401(k) plan that’s integrated with your payroll, then that can make things much easier. It’s very important to have a system that integrates payroll, 401(k) and CBP. That can simplify things tremendously. For example, 401(k) contributions can be taken directly out of payroll and CBP contributions can be taken directly out of the owner/employer’s bank account.
Before jumping headfirst into the world of CBPs, I recommend that high earning business owners and professional rolling it out in stages over time.
1. Start with a SIMPLE IRA.
2. Then move to 401(k) plan that you can max out--and make employee contributions.
3. Add a profit sharing component for employees which typically is in the 2% range and this will usually allow you to max out at $56,000 (under 50) or $62,000 (age 50 and over)
4. Once comfortable with the mechanics of a 401(k) and profit sharing, then introduce a CBP.
If you’re behind in your retirement savings, CBPs are an excellent tool for supercharging the value of your nest egg and can possibly allow you to retire even sooner than you thought. CBPs take a little more set-up and discipline to execute, but once those supercharged retirement account statements start rolling in, I rarely find a successful owner or professional who doesn’t think the extra effort was worth it.
Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail email@example.com.
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